The Age - Earnings Relationship Is Not What You Think

You know the workforce is getting older, right?

Whether it's because of improved health care allowing us to live longer and healthier lives, advances in assistive technology, eroded financial positions delaying retirement, or a shift in preferences, the worklife of the typical American is getting longer.

Even though I probably don't need to convince you of this, here are some statistics on labor force participation rates by age group for the years 2000 and 2009:

 

Among people between the ages of 55 and 65, the labor force participation rate has increased 5 percent. Among those 65 and over, it's increased 4.5 percent. (You'll also note a decrease in labor force participation rates among the 16 to 24 age group - we'll hope it's because more of them are taking advantage of educational opportunities!)

What does the aging workforce mean for employers? It means that they need to consider the full spectrum of challenges and opportunities presented by this demographic shift. Research conducted by Towers Perrin, on behalf of AARP, suggests that

... organizations that adhere to the conventional wisdom about older workers - specifically the notion that older workers are more expensive and less productive than younger groups - may miss a critical opportunity to maximize their talent base.

One of the "conventional wisdom" assumptions that this research addresses is that older workers are more expensive than younger workers because of higher wage and benefits expense. It turns out that this is, in most cases, incorrect. The Towers Perrin research found that cash compensation (including bonuses) for older workers were typical for the positions held.

The research also points out that "while average pay tends to increase initially with service and age, this increase in pay can also result from gains in employee competence or movement up the career ladder in an organization." This finding can be demonstrated empirically. Using data from the Current Population Survey, we can map out the relationship between age and earnings. The chart below shows the average weekly earnings - across all industries and occupations - by age group:

 

The chart above shows the age earnings profile for ten different years (2000 through 2009). While there is some variation from year to year, the general pattern we see is that earnings increase rapidly in the earlier years of the worklife, from the late teens / early 20s through the mid-40. From the mid-40s through the mid-50s, earnings are still increasing, but the rate of increase slows down: earnings "flatten out". After the mid-50s, earnings actually decline.

What explains the overall shape of the age earnings profile? On the "front-end" of the profile, earnings in the late teens / early 20s are increasing very rapidly as younger people transition from a "job" to a "career". Earnings are also increasing during this period because we are rapidly learning new skills, becoming accustomed to the way things are done in our profession, being promoted and moving up the corporate ladder, or even leaving our current position for the greener pastures of better compensation and more opportunities with another organization.

But one of the most interesting parts of the age earnings profile is the "flattening-out" of earnings in the mid-40s to mid-50s range, and the decline of earnings. What's causing this pattern?

Different explanations have been offered, ranging from the biology of aging, labor market dynamics, human capital theory, organizational dynamics, and outright age discrimination. Maybe it's because we can't continue to move up the career ladder (and continue to be financially rewarded for doing so) indefinitely. We eventually reach an upper limit, either because we are utilizing our potential to the fullest, or because there's simply nothing above where we currently are. Maybe it's because of bias on the part of those evaluating our performance and determining our pay increases. Some have argued that this pattern is simply an artifact of measurement error in the self-reporting of earnings, which may be larger for older individuals who work non-standard hours.

An interesting potential explanation for the decline in earnings after the mid-50s relates to what we're measuring. Terrence Clauretie argues that while earnings decline, total compensation (including benefits) declines much later and much less. He argues that fringe benefits - and specifically health insurance - become a "more valuable component" of total compensation as one ages.

Can this whole thing be explained by including health care? No. Clauretie calculates the value of health benefits two different ways in his analysis: (1) 5.8% of wages, and (2) the difference between the total amount of reported medical expenditures and the portion reported as self-paid by the employee. Neither measure completely eliminates the decline in earnings, not to mention that "older" doesn't automatically imply bigger health care costs for the employer. While there is some difference in health care costs between older and younger workers, there is significant variation in health care costs among individuals within the same age group. In fact, the University of Michigan Health Management Research Center found that indivdiuals' specific health risks are a better predictor of health care costs than age.

So health care doesn't explain it away. What's the answer? Unfortunately, I can't give you a definitive single reason for why earnings flatten out in our mid-40s to mid-50s, and then decline. For some readers, this may be a less-than-satisfactory explanation; if you're one of them, I apologize. My shortcoming is shared by many - no single explanation has ever been found in all of the empirical research that's been done on this issue. The truth is I'm not sure there is one right answer- I think it's a complex combination of a lot of different things. And the conversation takes on a whole new level of complexity - and becomes emotionally charged - when we introduce productivity into the mix (which is exactly what we'll do in my next Cafe post!)

What I can definitively tell you is that this pattern is not limited to the 21st century. This relationship was present in the 1970s, 1980s, and 1990s; it's likely that this relationship will continue into the future. And even if we don't fully understand the underlying reasons, this empirical pattern has poked a lot of holes in assumptions about older workers.

What's the upshot for compensation managers and designers? Older workers aren't more expensive workers. Real cash compensation does not increase indefinitely. At some point, usually around the age of 50, plus or minus five years or so, earnings begin to flatten out, after which they decline.

The biggest challenge of the aging workforce is designing the right rewards mix. It's not all about cash compensation. It's about offering flexibility, the ability to work as long as the employee wants to work, and an environment where all employees - regardless of age - have the opportunity to have new experiences, learn new things, and continue to grow.

Stephanie R. Thomas is an economic and statistical consultant specializing in EEO issues and employment litigation risk management. For more than a decade, she's been working with businesses and government agencies providing expert EEO analysis. Stephanie has published several articles on examining compensation systems with respect to equity. She is the host of The Proactive Employer, and is the Director of the Equal Employment Advisory and Litigation Support Division of MCG. 

Comments

[Laura Schroeder]

A great, comprehensive article, Stephanie! Thanks for shining the spotlight on this topic.